Previously, we published the Dr Wealth Dividend 50, which comprised the top dividend stocks in Singapore and Hong Kong. In this post, we aim to identify the best value stocks that exhibit growth, listed in the US, China/Hong Kong, and Singapore. You can download the complete list of 50 stocks below and read further to understand how the screening rules were applied.
Growth and Value are Joined at the Hip
Growth-oriented investors tend to overlook valuation, focusing instead on growth rates and future potential. This often leads to overpaying for stocks. On the other hand, value investors tend to find beaten-down stocks but may lack the quality to improve their situations, leading to stagnant share prices. Why not combine both approaches to achieve growth without overpaying? In fact, Warren Buffett sees no difference between growth and value investing—you need to evaluate both.
Typically, value stocks require a catalyst to unlock their value, such as a merger, acquisition offer, or earnings turnaround event. However, these catalysts are often unpredictable, except for the most reliable driver of value: growth. Therefore, we believe that focusing on value stocks with growth potential will serve as its own catalyst to unlock value over time.
For growth, we screened for a 5-year Compound Annual Growth Rate (CAGR) in revenue and free cash flow (FCF), with each at least 10%. We believe that 5 years is a reasonable timeframe to assess growth rates, and 10% is significantly higher than the GDP growth rate of most developed countries. We included FCF growth rates to ensure that businesses are generating increasing cash flow and not just accrual profits.
As for value, we drew inspiration from the Pacer Cash Cow series of ETFs, which use FCF yield rankings to determine the cheapest stocks. Instead of dividing FCF by market cap, enterprise value (EV) were used, as it is more robust, considering both cash and debt. This metric alone has proven powerful in delivering above-average returns, as evidenced by the Pacer US Cash Cows 100 Index. We ranked over 13,000 stocks listed in the US, China, Hong Kong, and Singapore by FCF/EV yield, identified the top 20% with the highest FCF/EV yield, and then selected the top 50 after applying all other screening filters.
Quality Stocks Please…
Value stocks may include companies that are cheap for a reason and unworthy of investment. To improve the quality of our picks, we applied a quality filter based on Gross Profitability, inspired by Robert Novy-Marx’s research. We ranked the stocks by Gross Profitability and identified the top 20%, forming a group of the best quality stocks.
This metric tends to favor asset-light businesses such as tech while penalizing asset-heavy businesses like financials. Despite this imperfection, we are satisfied with the diversification, as the 50 stocks span 9 sectors, with a balanced weightage except for a 30% allocation to consumer discretionary. This may be due to current market conditions where high inflation affects this sector, leading to poorer stock performances and higher FCF/EV yields.
Geographically, there are 25 US-listed stocks, 24 in China/Hong Kong, and 1 in Singapore. This distribution is not surprising given the larger number of stocks listed in the US and China/Hong Kong markets compared to Singapore.
Consistency of Growth
Our final criterion, though subjective, involves assessing the consistency of growth over the past 5 years. We don’t expect every stock to show higher revenue and FCF each year, but there must be a general upward trend.
For example, Anta (SEHK:2020) shows a consistent upward trend in both revenue and FCF, which we seek in our selections.
We avoid stocks with unstable or cyclical business patterns, such as OraSure (NASDAQ:OSUR), which exhibited irregular and negative FCF for several consecutive years.
Download the Full List of Dr Wealth Value Growth 50
With the above criteria, we derived the Dr Wealth Value Growth 50 list, which we believe comprises good businesses with growth potential that are currently undervalued. You can download the list by entering your email below. It could be an excellent starting point for your stock hunt, hopefully leading to some great investment opportunities!